Bring peer-to-peer lending to Canada!

Peer-to-peer (P2P) lending is not currently not allowed in Canada but I think it should be. In this blog, I want to talk about what P2P lending is, why it’s not allowed in Canada, and lay out a case for why it should be allowed in Canada.

WHAT IS P2P LENDING

Let’s start with the basics — what is P2P lending?

Peer-to-peer lending is crowdsourced borrowing. An individual who needs money can go to a p2p site (like Prosper.com) and post their need for cash. Lenders can collectively lend money to the borrower. So if someone needs $1000, a group of lenders can each chip in a certain amount — anywhere from $25 up to the full amount — to lend money to the borrower. The borrower then pays back the full amount plus interest.

I need to make one clarification here: P2P lending (crowdsourced borrowing) is different from crowdfunding (like through Kickstarter). In very general terms, borrowing comes with an expectation to pay back while funding is more like a donation.

WHY IS P2P LENDING A GOOD THING?

People need different sources of money and not all money can come from banks or other “formal” lending institutions. This is why payday loan companies offer a valuable service (even though they are frequently disparaged by people who don’t use them)… because payday loan companies serve a clientele who cannot or don’t want to go do through a bank. The same with P2P lending.

Why use a P2P lending service instead of a bank? Borrowers who use P2P services might be able to go through a bank, and they would likely get better interest rates if they do. But there might be reasons why they don’t want to go through a bank. Perhaps they don’t have the credit rating or don’t want to take the hit on their credit score. And P2P is certainly faster than a bank loan, and while they might be able to access just as much (or more) than a bank loan.

Why use a P2P lending service instead of credit cards or payday loan services? A P2P lending service gives borrowers access to money at a rate that is frequently better than credit cards or payday loan companies, and at amounts potentially more than credit cards and payday loan companies will lend.

On the lending side, lenders minimize their risk (by only lending a smaller amount, say $50 or $100 at a time) but get a higher return than they often would with a mutual fund (especially in today’s stock market).

BUT AREN’T THERE RISKS?

I’m not naive enough to suggest that P2P lending is all roses and sunshine. On the borrowing side, it’s possible to get into debt too much with P2P lending (no different than credit card debt, I suppose), and the interest rates can be high-ish in some cases. And on the lending side, there are defaults, just as there would be for banks in more conventional loans.

But there are risks in everything we do (there’s even risks associated with doing nothing) and as P2P lending sites like Prosper.com get better and better, those risks decrease. (Plus, smart lenders decrease risks by spreading their lending across several loans instead of dumping it all into one loan).

Like any other investment, I’d rather have the option to choose to pursue the opportunity or not… instead of what I have now: It’s decided for me.

WHY CAN’T CANADIANS PARTICIPATE IN P2P LENDING?

When I first learned about Prosper.com a few years ago, I looked into signing up. No-go. Canadians cannot participate. I tried again recently and it’s still the same.

I haven’t found a lot of information on why this is the case but Wikipedia has a good and clear (yet simple) explanation, which I’m summarizing here: Giving someone money with the expectation of making a profit is a type of “security” (just like other investments are types of securities). Securities are highly regulated. (That’s a good thing). In the US, they are regulated by the SEC.

In Canada, things are different apparently. (I’m still learning this part, in spite of being a formerly licensed investment advisor and working for in the financial industry since 1999 — yeah, that’s embarrassing, although in my defense, most of my time has been spent focusing on the US financial industry!). In Canada, we don’t have a a federal securities regulator akin to the SEC. Rather, our Canadian Securities Administrators (CSAs) are provincial — each province has its own regulator. (Observation: Is it strange that a republic like the US has a federal regulator while a parliamentary democracy has provincial regulators? Maybe I’m the only one who thinks that is weird).

Okay, as I dug deeper into some research, I found one company that was granted a license to operate a online peer-to-peer lending platform (for accredited investors only). The Ontario Securities Commission ruling from September 8, 2009 is here. The company, CommunityLend, has actually been winding down their operations since February 2012 in order to pursue a consumer lending business. In their blog post about their wind-down, they wrote a very telling analysis of the state of P2P lending in Canada: “We observed that P2P Lending, as it needs to operate within the Canadian regulatory system today, has enough headwinds blowing against it that getting to a significant scale was going to be both expensive and difficult.” (View the CommunityLend blog post: Onwards and Upwards from February 23, 2012)

Sadly, the only apparent Canadian P2P lender, already hampered by the “accredited investor” requirement, has been shut down.

Our provincial regulators have not seen fit to agree that P2P lending is worthy of making it available for all Canadians. Therefore, no average investor can participate in P2P lending here in Canada.

Why is this?

Here are a few guesses, based on totally unresearched, anecdotal observations and experience:

Canada is more risk-averse than the US. (Or, put slightly more positively, the US is more entrepreneurial than Canada).

Allowing P2P lending in Canada requires the agreement of all CSAs, which I’m sure is no easy task.

The potential for lost tax revenue from out-of-Canada P2P participation is likely a key factor in why Canadians can’t participate in a site like Prosper.com.

We can’t lay fault at only the regulator’s feet. As I tried to research peer-to-peer lending in Canada, I quite simply saw a gaping void in the information. There was some info when CommunityLend first got off the ground in 2008-ish but it’s been relatively quiet since. Even a site that attempted to document the microlending industry in Canada was active until about 2010. It seems like Canadian regulators don’t want P2P lending and Canadian investors don’t care.

The result is that borrowers must look to more conventional sources for loans while investors must look to more conventional sources for investing. Any informal pay-back-with-interest loans are done offline, face-to-face, and will still rob the government of their tax income.

A CASE FOR P2P LENDING IN CANADA

P2P lending in Canada takes an unregulated activity that is already going on and makes it regulated, and therefore safer (because of disclaimer requirements and educational opportunities and licensing).

P2P lending in Canada gives an option to borrowers who don’t want to use some of the conventional borrowing sources (i.e. bureaucratic banks or high-interest payday loan lenders).

P2P lending in Canada gives an option to investors who are aren’t seeing adequate returns from the conventional stock market.

P2P lending in Canada allows the country to catch up to other nations that have recognized the inevitability of social lending.

P2P lending in Canada regulates an activity that could generate tax revenue for the government (in the same way that other interest-bearing investments generate tax revenue).

Thanks for the comment, Tate. So you’re suggesting a site that would be a broker connecting borrowers and lenders, rather than a site that collected and dispersed money from multiple lenders to a single borrower. I can see that model easing some of the concerns of the regulatory bodies. I like that!

Just thinking “out loud” as I plug some of the peer-to-peer characteristics into the model you are suggesting:

One of the advantages of the current peer-to-peer model is that risk is minimized when many investors each lend a small(ish) amount of money to a single borrower. I’m trying to wrap my mind around how to avoid flooding a borrower with hundreds of phone calls calls from investors who each want to give a small amount.

The other advantage to the current peer-to-peer model is that there is a bit of a barrier between investor and borrower, making it harder for investors to retaliate against unpaid debts. So using your idea, the site may need to ensure that the site brokers a connection without revealing identifying information that could ultimately endanger a debtor who doesn’t pay.

I need to think a little more about what exactly the Canadian regulatory bodies have a concern with and how your brokerage idea could address those concerns. (Well, I know what I’m doing for the rest of the day!)

LL, these are entrenched, bureaucratic governments (and not just one… perhaps as many as 13, if each of the territories have their own). I have a hard enough time getting answers on the easy business questions I have, I can’t imagine someone else doing that 13 times with a business that breaks new ground.

Once that that is over, you’ve got the public buy-in issue. There are just one-tenth of the people that the US has and we’re collectively more risk averse.

So a peer-to-peer business will need tireless lobbyists and deep pockets and patience.

But maybe this is an idea whose time has come. And enough people call their Members of Parliament, all these problems could simply vanish.

It’s an interesting article, but your affection for regulation is unwarranted.

Regulation doesn’t make it safer. Yes, it takes away some of the “buyer beware” aspect of the transaction. But if you don’t like thinking for yourself (and we all don’t from time to time) you can easily stay safe by sticking to the major providers who won’t sacrifice their reputations by trying to rip you off.

The regulation actually makes many transactions less safe by making them illegal. Black market transactions are inherently less safe because there is no legal system to arbitrate disputes. That means disputes are often handled with violence or not justly handled at all.

Despite the good intentions, regulations actually have the opposite of the desired effect.

Hi Paul. Thanks for the comment. I must not have been very clear in my blog post if I came across as having affection for regulation.

I really don’t. I really dislike it, in fact. It’s burdensome. I understand why we have it but I wish more people would learn to think, to do due diligence, to study finance, etc. I prefer the market to sort things out rather than government intervention.

But I mention regulation a lot in my post because I realize that I live in a highly regulated environment and that is exactly what is keeping P2P lending from entering Canada. I wish there was less but whoever does choose to come to build a P2P lending model in Canada will need to learn to work within this complex system.

If I get a USD chequing account through my Canadian bank, could I lend those funds in the US?

As a next step, could a Canadian entrepreneur set up a CAD wrapper as a vehicle to lend in the US p2p market? Something like: Canadians would pool funds, which would be used to buy shares of US P2P loans. To exit, you’d need to sell you loan part to other Canadians. Daily currency hedging, perhaps, with the fee for that charged to shareholders/pool-members.

A quick glance at Prosper’s compliance page tells me that the individual must have a US address to participate. So a USD chequing account through a Canadian bank might not be enough. And, apparently, even my US corporation (which has a US address and US bank account) wouldn’t work either, since this is for individuals only. (Disclaimer to that last paragraph: Other P2P sites might differ). I suspect there are some IRS considerations that influence this decision.

What’s interesting about your pooled funds approach is that it’s an extra layer of pooling (since P2P is already pooling), which might bring some comfort to our extra-conservative securities legislators. Practically speaking, though, we’re still missing a piece of the puzzle — to get those pooled Canadian funds through a US-based conduit.